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A ray of light in these dark days: Living standards have risen far more than we think

Posted by on October 25, 2018 in Blog, Economists, Nobel Prize | Comments Off on A ray of light in these dark days: Living standards have risen far more than we think

A ray of light in these dark days: Living standards have risen far more than we think

The media seems full of gloom at the moment. Chaos over Brexit, Saudi Arabia, potential nuclear escalation between the US and Russia – you name it, people are worried about it.

A ray of light is shone – an apt phrase as you will see – by the work of Bill Nordhaus, a Yale economist who was the co-winner of this year’s Nobel prize in economics, along with Paul Romer.

Over the past two decades or so, Nordhaus has worked mainly on integrating climate change into macroeconomic models, and was awarded the accolade for this research. He is no knee-jerk lefty in this respect. For example, he was a prominent critic of Nick Stern’s report on climate change, which was commissioned by Gordon Brown.

But in my view, Nordhaus should have been awarded the Nobel prize years ago for his brilliant work on measuring how well-off we all are.

The conventional measure of GDP per capita is widely criticised these days. But instead of just whinging from the sidelines about how economics is wicked and useless – sadly a common feature in modern critiques – Nordhaus actually tried to do something about it.

In 1972, he and James Tobin (another future Nobel laureate) developed the Measure of Economic Welfare. The two economists took GDP as their starting point. They adjusted it to include, for example, an assessment of the value of leisure time and the amount of unpaid work in an economy.

Taking these factors into account means we are better off than the conventional GDP measure suggests.

The most dramatic paper by Nordhaus, published in 1996, is on the seemingly obscure topic of the history of lighting. He analysed the topic over a vast time span, from the first sources of artificial light – the fires used by humanity around one million years ago – to the modern fluorescent bulb.

The focus of the paper was not the technology as such, but whether the standard ways of measuring the price of lighting captured the massive improvements in quality which have taken place, particularly in the twentieth century.

Nordhaus concludes that the traditional price indexes of lighting vastly overstate the increase in lighting prices over the last two centuries relative to quality. So the true rise in living standards has consequently been significantly understated.

The magnitude of the difference is vast. Nordhaus estimates that the price measured in the conventional way rose by a factor of between 900 and 1,600 more than the true price.

Bodies such as the Office for National Statistics receive information about the economy in current prices. If output in any particular sector has increased, a key task for them is to decide how much of that is due to a rise in prices and how much to a genuine increase in output.

Rapid quality change means that the conventional ways of doing this simply cannot cope. Price rises are overstated, and in consequence “real” changes in output and living standards are understated.

The implication of the apparently esoteric work Nordhaus did on lighting is that modern technology such as the internet has increased living standards far more than the official statistics indicate. Finally some news to be cheerful about.

As published in City AM Wednesday 25th October 2018

Image: Lightbulb by lenavasilevs via Pixaby is licensed under CC0 1.0 Universal

Can we innovate better outside the EU? Economic lessons from the Nobel prize winner

Posted by on October 18, 2018 in Blog, Economists, Nobel Prize | Comments Off on Can we innovate better outside the EU? Economic lessons from the Nobel prize winner

Can we innovate better outside the EU? Economic lessons from the Nobel prize winner

Gordon Brown’s time as chancellor will be remembered for many things.

A sense of humour would be conspicuously absent from this list.

But he provoked a great deal of mirth unintentionally in a speech shortly before the 1997 General Election on the theme of “post-neoclassical endogenous growth theory”.

Perhaps the last laugh is with Brown. The person who invented the concept, the New York professor Paul Romer, is a joint recipient of the 2018 Nobel prize for his work in this area.

The standard economic theory of growth was set out over 60 years ago in a brilliant paper by the MIT economist Bob Solow.

Solow’s theory was not concerned with the short-run fluctuations in GDP growth over the course of the business cycle. He set up a framework for thinking about what determines growth in the longer run.

Solow argued that the growth in output was related to the growth of inputs of labour and capital into the productive process.

This seems obvious. But there was an extra ingredient: innovation.

This embraces a wide range of concepts, from becoming more efficient at producing what you already do, to major scientific breakthroughs.

Economists quickly used Solow’s model to estimate empirically what was really driving economic growth. In western economies, the answer was almost always the same. The amounts of labour and capital used had risen, but nowhere near enough to account for how much growth had taken place.

So the key factor in economic growth in the longer run is the amount of innovation which is carried out.

This insight is directly relevant to the debate over Brexit. Over a 10 or 20 year horizon, the key question is not the terms under which we leave – it is whether we will be able to innovate more effectively in or out of the EU.

The basic shortfall of the approach is that innovation itself is not explained by Solow’s model. Innovation is, in the jargon, “exogenous”. In other words, it is determined externally to the model.

This is where Romer enters the stage. His seminal paper in the Journal of Political Economy in 1986 is full of heavy-duty maths. The crucial difference with Solow is that the rate of innovation is determined within the theoretical model itself – hence the phrase “endogenous” – by profit-maximising firms.

Physical capital such as machinery, warehouses, and roads play a role in both the Solow and Romer theories of growth. But Romer introduced the key concept of knowledge as the basic form of capital.

Policymakers across the west in the past two decades have been obsessed by the “knowledge economy”. This is not, as Tony Blair and many others believed, simply a matter of sending more and more people to university. It is about how to encourage innovation.

Both the Solow and the Romer models are highly abstract – Solow, for example, began his article with the phrase “all theory depends on assumptions which are not quite true”. But both have been highly influential with policymakers, and illustrate the vital economic importance of ideas.

As published in City AM Wednesday 18th October 2018

Image: Gordon Brown by World Economic Forum via Wikimedia is licensed under CC-BY SA_2.0

Economies of the future will have to engage with the world, not just the EU

Posted by on October 11, 2018 in Blog, Brexit | Comments Off on Economies of the future will have to engage with the world, not just the EU

Economies of the future will have to engage with the world, not just the EU

The fire and the fury rage from day to day around the outcome of the Brexit process.

The discussion has lost sight of the longer-term context in which both the UK and the EU will operate, regardless of the precise deal which is or is not struck.

In the 1960s, the countries which are now in the EU-bloc represented just under 30 per cent of world output. This has already fallen to less than 15 per cent.

And on any reasonable extrapolation of trends, it will dip under 10 per cent at some point in the next two decades.

This does not mean that Europe is getting poorer. Far from it. It means that the rest of the world, especially Asia, has been becoming richer much faster.

The Brookings Institute calculations released last week were a marvellous piece of news.

For the first time in human history, just over 50 per cent of the world’s population, or some 3.8bn people, live in households with enough discretionary expenditure to be considered either “middle-class” or “rich”.

This has been achieved by capitalism. Until the 1980s, for example, in their own ways both India and China were centrally planned economies. Once they shifted to the principles of market-based economies, they have boomed.

The Brookings authors estimate that in 2030 – just a decade and a bit away – the middle-class markets in China and India will account for $14.1 trillion and $12.3 trillion, respectively.

This compares to their projection of the US middle-class market at that time of $15.9 trillion.

Okay, so their decimal points give an air of spurious accuracy to the forecasts – but the general point is clear. Whether Europe likes it or not, the vast majority of world trade will take place outside the EU.

The second key point to note is that Europe has hardly been a major economic success story. The narrative peddled by Remainers seems stuck in the past.

If we travel back in time to, say, 1970, it becomes easy to believe that the European economies are so dynamic that it is essential for us to have the closest possible links with them.

In the 1950s and 1960s, annual real GDP growth in the economies which then made up the EU averaged over seven per cent. In contrast, the UK barely scraped above three per cent.

Since then, the long-term average growth rate of the original EU countries has fallen more or less continuously to less than two per cent a year.

The UK’s has also dropped, but not by much. Over the past 20 years, our GDP has risen by 2.1 per cent a year. France registers 1.6 per cent, Germany 1.5 per cent, and Italy a mere 0.6 per cent.

Regardless of the eventual Brexit terms, successful economies in the future will simply have to engage with the rest of the world, rather than depend upon the EU.

As published in City AM Wednesday 10th October 2018

Image: Chinese Girls by David Stanley licensed under CC-BY_2.0

 

Bereft of new ideas, Jeremy Corbyn’s Labour Party is dead set on sticking its head in the sand

Posted by on October 4, 2018 in Blog, Politics | Comments Off on Bereft of new ideas, Jeremy Corbyn’s Labour Party is dead set on sticking its head in the sand

Bereft of new ideas, Jeremy Corbyn’s Labour Party is dead set on sticking its head in the sand

One of the most dispiriting aspects of the Labour Party conference, which ended last week, is how deeply conservative the political left has become. Its remedies for Britain’s problems look to the past and not the future. Far from embracing new technology, the left is hostile to it.

This was not always the case. Labour under Harold Wilson won a closely contested election in 1964. Wilson’s key phrase – “the white heat of the technological revolution” – became the butt of parodies. But it encapsulated Labour’s appeal. Tony Blair, for all his faults, projected an image of modernity with his “Cool Britannia”.

Now, we have the grim pledge to turn the clock back and renationalise the railways. This was first done in 1948. But there is no sense that anything innovative will be done.

In fact, the old British Railways, as it was then called, was subsequently plagued by massive underinvestment in modern technology and equipment.

Ironically, given Labour’s attacks on the short-termism of the City, it was precisely in the nationalised industries that such behaviour was rampant.

If fares had to rise to fund new investment, the political incentive facing the Minister of Transport was to refuse the increase. Given the choice between political popularity in the here and now, and the longer-term benefit to the industry, guess which one usually won.

Labour argues that the profits currently being made by the private rail companies would be ploughed back to improve the service. The much more likely outcome is that the money will be used to featherbed jobs and boost the pay of those employed in the sector.

Let’s leave aside the fact that Network Rail, the one part of the railways still in public ownership, has shown itself to be unfit for purpose.

The problems started immediately after nationalisation 70 years ago. The historian John Bew published a magnificent biography of Clement Attlee in 2016. Attlee led the 1945-51 Labour government, by far the most radical in British history. Attlee himself served with great bravery in the First World War, was a fervent patriot and supporter of the monarchy, and stressed individual responsibility as much as individual rights.

An ordinary railwayman features in a snippet in the book. He had been a keen supporter of nationalisation, but six months after the event, he had changed his mind.

Why? Because “where there used to be one inspector, now there are two” – jobs for the public sector middle class. Little wonder that Corbyn’s Labour is so keen on the idea.

The left in general seems bereft of new ideas and lives in fear of new technology. They want to ban Uber and AirBnB. They want to bring Google and Facebook to heel not by innovation and competition, but by regulation. Their house journal, the Guardian newspaper, is filled with savage attacks by liberal arts graduates on “algorithms”.

To make a success of Brexit, we need to embrace innovation. As far as the future is concerned, Labour is just sticking its head in the sand.

As published in City AM Wednesday 3rd October 2018

Image: Jeremy Corbyn by Rwendland licensed under CC-BY_SA 4.0

At long last, economists appreciate that private debt was the catalyst for the crisis

Posted by on September 27, 2018 in Banking, Blog, Economic Theory, Economy | Comments Off on At long last, economists appreciate that private debt was the catalyst for the crisis

At long last, economists appreciate that private debt was the catalyst for the crisis

This month saw the tenth anniversary of the collapse of Lehman Brothers, a collapse which precipitated one of the only two global financial crises of the past 150 years.

The late 2000s and early 1930s were the only periods in time when capitalism itself has trembled on the edge of the precipice.

It was in November 2008 that the Queen put her famous question about the crisis to the academics of the London School of Economics: “Why did nobody notice it?”

The answer is simple. In the models of the economy at the time, finance did not matter.

Mainstream economists did not notice the massive financial imbalances in the economy, because in their models, any problems that might link to these imbalances were assumed away.

To be of any use, all scientific models have to make simplifications of reality. But orthodox macroeconomics took a step too far. It assumed that the workings of the whole economy could be explained by analysing the theoretical behaviour of just a single decision maker. In the jargon, this is the “representative agent”.

The agent is a device which economists used to model the economy. It was extremely clever, and could solve hard mathematical problems – calculating how the decisions of average consumers and companies would affect the macroeconomy.

These kinds of models go by the splendid name of “dynamic stochastic general equilibrium models”, or just plain “DSGE” to their friends. But at its most basic, the problem with such economic models was that there was only one decision maker in them.

Having just two, a “creditor” and a “debtor” for example, would have helped a lot.

Over the past decade, economists have been scrambling to incorporate other financial factors into their models, such as household debt. Key contributions to this research are discussed in the latest issue of the Journal of Economic Perspectives.

Bizarre though they may seem, DSGE models now finally recognise the potential importance of household finance in causing crashes.

A particularly interesting paper in the journal is by Atif Mian of Princeton and Amir Sufi of Chicago. Their focus is considerably wider than the crisis of the late 2000s in the United States. They quote empirical studies across some 50 countries with data going back to the 1960s. They found that a rise in household debt relative to the size of the economy is a good predictor of whether GDP growth will slow down.

Rickard Nyman, a computer scientist at UCL, and I applied machine learning algorithms to data on both public and private (households and commercial companies) sector debt in both the UK and America. We find that the recession of 2008 could have been predicted in the middle of 2007.

Perhaps the most striking result is that public sector debt played little role in causing the crisis. The driving force was the very high levels of private sector debt.

A critic might say that this is simply a case of generals fighting the last war.

True, we don’t know whether a completely different nasty event lies around the corner. But at long last, economists appreciate the fundamental importance of debt and finance in Western economies.

As published in City AM Wednesday 26th September 2018

Image: Her Majesty The Queen by UK Home Office on Flickr licensed under CC-BY 2.0

The Bank of England’s own data negates Carney’s overhyped house price warning

Posted by on September 20, 2018 in Banking, Blog, Brexit, Housing | Comments Off on The Bank of England’s own data negates Carney’s overhyped house price warning

The Bank of England’s own data negates Carney’s overhyped house price warning

No one can tell them quite like Mark Carney, the governor of the Bank of England.

He appears to have briefed the cabinet last week that house prices could fall by 35 per cent in the event of a no-deal Brexit.

To be fair, the Bank did try to qualify this figure by saying that it was just the worst of several scenarios which analysts had produced in order to stress test the balance sheets of the commercial banks.

But the 35 per cent house price drop has now become embedded in the public narrative about Brexit.

Just how likely is such a massive drop to take place?

We do not know exactly how the Bank did its stress tests. But, typically, the worst-case scenario in such tests is either one which is judged to have a one in 20 chance of happening, or, if you are setting really demanding standards for the test, just a one in 100 chance.

When trying to assess these odds, an important input is what has happened in the past. The past may of course not be a reliable guide to the future, but it is all we have to go on.

An analogy from the sporting world might help. Every year, three clubs from the Championship are promoted to the Premier League. What are the chances of one of them being relegated after their first season in the top league?

We can look at the historical record since the Premier League began in 1992/93, which helps us form an initial view. We might then qualify it, and set the benchmark – a 44 per cent chance of relegation, since you ask.

With house prices, we can go much further back in time, as far back as 1845 to be exact. And the source of this information on nearly two centuries of house prices data is none other than the Bank of England itself.

Over all this time, there has never been a cumulative fall in the Bank’s house price series of as much as 35 per cent.

The closest we have seen was in the opening decade of the twentieth century in the run-up to the First World War. The UK economy was pretty much in the doldrums, and between 1902 and 1909, prices fell by a total of 33 per cent.

Nothing else remotely compares to this drop.

There have been two global financial crises over this period. In the 1930s, house prices fell by only seven per cent between 1929 and 1934.

And following the most recent crash, the reduction between 2007 and 2009 was 13 per cent.

In America, the Case Shiller house price index was 21 per cent lower in 2011 than it was in 2006, but this is the largest fall in that particular database.

The governor is therefore inviting us to believe that, in the event of a no-deal Brexit, house prices may fall by more than they have ever fallen since the Bank’s own data began in 1845.

How did the Bank arrive at this figure? I think we should be told.

As published in City AM Wednesday 19th September 2018

Image: Mark Carney by Bank of England on Flickr licensed under CC-BY-ND 2.0

The economic answer behind superstar salaries

Posted by on September 13, 2018 in Blog, Sport | Comments Off on The economic answer behind superstar salaries

The economic answer behind superstar salaries

Rugby Union’s Premiership season is underway again.

This is yet another professional sport which operates on the principles of socialism: the money all ends up in the pockets of what we might call the “workers”.

In a sport which was allegedly only played by amateurs until the mid-1990s, earnings have boomed. The average salary in the Premiership is over £200,000, and the stars are paid around the one million mark.

As a result of such payments, most of the Premiership clubs are only kept afloat by huge loans from their owners. Their accounts for 2016/17 were released at the end of August. Bruce Craig has put £18m into Bath since 2010. Bristol owe more than £20m. Wasps have liabilities approaching £50m.

But the players’ earnings are mere shadows of those of the top American sports stars. According to Forbes magazine, in the year to June 2018, the 100 best-paid athletes made $3.8bn between them. The boxer Floyd Mayweather topped the list with $285m.

Stars of popular culture pull in similarly staggering amounts. George Clooney earned $239m and Dwayne Johnson was the second highest among male actors at a mere $119m.

These vast sums appear to pose a challenge to economic theory. These players and actors are very good, but they are not so stupendously better than others who get paid very much less. How can this be explained?

The answer was provided in a brilliant article by the American economist Sherwin Rosen as long ago as 1981, entitled “The economics of superstars”.

Rosen based his theory on the fact that activities such as watching a sport or going to a film involve what economists call “joint consumption”.

If I am watching Arsenal, say, on the television, it does not matter how many other people are viewing at the same time. The game is still available for me to watch. In contrast, if I book a table at a popular restaurant or a particular seat on a flight, no one else can use it.

In 1880, if you wanted to hear a particular singer, you had to go to a live performance. Perhaps a thousand people could enjoy the joint consumption of the product. In 1980, tens of millions could watch on television.

Rosen, writing well before the internet, argued that advances in communications technology such as radio and television increased enormously the potential size of markets involving joint consumption. As he put it so succinctly, “the possibility for talented persons to command both very large markets and very large incomes is apparent”.

For example, the football played in England’s Premier League is in general better than that in the Scottish Premiership. But the English league rakes in well over £1bn a year in television rights, and Scotland less than £20m.

It is the combination of the joint consumption nature of these services and advances in communications which mean that a relatively small number of sellers can in principle service the entire market.

The more talented they are, the fewer still are needed. And that’s how they are able to earn so much.

Paul Ormerod 

As published in City AM Wednesday 12th September 2018

Image: Twickenham Stadium by David Iliff licensed under CC-BY-SA 3.0

Unemployment down, GDP up – there’s no logic for a public spending boost now

Posted by on September 6, 2018 in Blog, Economy | Comments Off on Unemployment down, GDP up – there’s no logic for a public spending boost now

Unemployment down, GDP up – there’s no logic for a public spending boost now

Despite the warmth of the days, there is a distinct autumn feel to the mornings.

And in the autumn, thoughts begin to turn to the Budget.

Speculation has already begun about what the chancellor Philip Hammond might or might not do.

For Labour, recent weeks have been dominated by Jeremy Corbyn’s alleged antisemitism and undoubted incompetence. So the anti-austerity tour of Britain by shadow chancellor John McDonnell, begun in Hastings in July, has scarcely obtained a mention in the media.

McDonnell obviously believes that there is a need to “end austerity”. He is far from being alone.

It is remarkable how this anti-austerity narrative continues to pervade political and economic discourse – it is as if the UK were in the grip of a massive recession.

In reality, the economy continues to do well. GDP is now over 18 per cent higher than it was at the trough of the recession in the first half of 2009. Unemployment has fallen steadily since the Brexit vote, and now stands at its lowest rate since February 1975.

The name of John Maynard Keynes is frequently invoked by those who want to “abandon austerity” and increase public spending. Yet in his major book The General Theory of Employment, Keynes stated very clearly: “when full employment is reached, any attempt to [stimulate the economy] still further will set up a tendency in money-prices to rise without limit”.

In other words, according to Keynes himself, at full employment any further stimulus will simply lead to higher inflation, with no benefit to output or employment.

Unemployment is at a 40-year low, while employment is at a record high, with 32.3m people in work – an increase of 3.4m from the depths of the financial crisis. This sounds like full employment in anybody’s language.

The overall shape of the recovery since 2009 has been balanced. Consumer spending has actually grown less than GDP, by just over 16 per cent since 2009 compared to an 18 per cent rise in GDP. Capital investment by companies has gone up by 35 per cent.

Public spending has also risen, but only by seven per cent (all figures after allowing for inflation).

This has been a recovery generated by the private sector.

The same point applies even more strongly to the US. Compared to the low point of the recession in 2009, public spending has actually fallen by three per cent, though there has been a modest rise in employment in that sector of 100,000. In contrast, the private sector has roared away: 19.5m net new jobs have been created since the winter of 2009, and GDP is up by over 22 per cent.

As in the UK, an important driver of the recovery in America has been investment by firms. This has grown by no less than 54 per cent compared to 2009.

There is no case at all for stimulating the economy by increasing public spending (funded by increased taxes) and abandoning so-called austerity, not when the private sector has done such a good job on its own.

As published in City AM Wednesday 5th September 2018

Image: Money by Max Pixel is licensed under CC0 1.0 Universal

 

From Venezuela to East Berlin, people will always choose capitalism over socialism

Posted by on August 29, 2018 in Blog, Capitalism, Socialism | Comments Off on From Venezuela to East Berlin, people will always choose capitalism over socialism

From Venezuela to East Berlin, people will always choose capitalism over socialism

How many people across the world in the history of humanity have fled from a capitalist country to a socialist one?

There was much amusement at the height of the long miners’ strike of 1984/85. A National Union of Mineworkers official from Yorkshire, a crony of Marxist trade unionist Arthur Scargill, sought sanctuary in the Stasi-controlled state of East Germany. He apparently felt unsafe under the jackboot of the Thatcher regime in the UK.

In the 1930s, some tens of thousands moved to Stalin’s Soviet Union, including the father of General Wojciech Jaruzelski, the leader of the last Communist government of Poland in the 1980s.

According to the euphemism used by the late Robert Maxwell in his biography of Jaruzelski, the father then “took a job in the north-east of the Soviet Union”. In other words, he was sent to the Siberian labour camps. He was lucky. Most of the other Poles who moved to the Soviet Union were subsequently shot.

These incidents stick in the mind precisely because they are so rare.

In contrast, when given the chance, millions flee from socialism. Venezuela is but the latest example. According to the United Nations, well over two million people have already escaped, taking with them just whatever they can carry.

The Berlin Wall was constructed in 1961 to prevent people moving from socialist East Germany to capitalist West Germany.

As post-war reconstruction got underway in the 1950s, around 3.5m left for a better life in the West – more than 10m translated into UK population terms. The Wall was built to keep them in.

The problem which the western countries have is not in keeping their own populations in. It is keeping others out, whether it is by Donald Trump’s wall in the US or Matteo Salvini’s refusal to allow boats of refugees to land in Italy.

The reason is simple. Economies based on market-oriented principles work much better than centrally planned ones. Capitalism, for all its faults, offers a much better lifestyle than socialism.

In the 1950s, South Korean living standards were not much better than those of sub-Saharan African countries. Now, South Korea is rich, while the North remains trapped in poverty. High-security levels are imposed by the latter to keep people in place. If they were removed, the country would rapidly become de-populated.

A fundamental concept in economic theory is that of revealed preference. People reveal what they really want not through answers to survey questions, but by their actions. If I say I prefer Pepsi to Coke but always buy Coke, I reveal that I actually prefer Coke.

Given the chance, over the years many millions of people have left socialist countries for capitalist ones. People were even willing to risk death to try to escape the old Soviet bloc countries.

By their actions, people reveal their preferences.

The financial crisis, scandals like Carillion, inequality and homelessness – all these are sticks for “useful idiots”, in Lenin’s phrase, to beat capitalism. But the point cannot be made often enough: whenever people are given the choice, they prefer capitalism to socialism.

As published in City AM Wednesday 29th August 2018

Image: Berlin Wall by Flickr is licensed under CC BY-SA 2.0

 

The economics of tourist overload

Posted by on August 23, 2018 in Behavioural Economics, Blog, Tourism | Comments Off on The economics of tourist overload

The economics of tourist overload

I am in Edinburgh for a few days at the Festival, where even Jeremy Corbyn has appeared. Disappointingly, he was not playing the role of Carmela Soprano, the mafia don’s wife who is always present but never involved.

Previously, I had been on Skye. Last month, I attended a conference in Venice. Edinburgh, Skye, Venice, all these locations bring home directly the problem of tourist overload.

This tendency of tourists to flock to certain places, whilst neglecting most others, raises questions for the economic theory of rational consumer choice.

Skye is very attractive, but so are other Scottish islands. The Piazza San Marco is stunning, but so are the cathedral squares in other Italian cities. From a rational choice perspective, it seems hard to account for the fact that visitor numbers here are so much greater than in their competitors.

The theory does help explain why Skye as a whole is much more popular than, say, Mull. It has a bridge, whereas the other islands have ferries. So less time and effort are required to get there.

But this framework appears to struggle with the massive concentrations of tourist numbers at particular locations on the island itself.

To escape the crowds, I suggested to my wife that we drive down Glen Brittle, an austere and bleak glen which finishes at a dead end.

I was astonished. A few miles along, the single-track road was virtually blocked by hundreds of vehicles, both on the road and balanced precariously on the boggy verges. The attraction was the Fairy Pools, a series of small pools and waterfalls in one of the many streams which flow down from the hills.

Now, there are literally hundreds of such waterfalls in the Highlands, many of which are more dramatic. From a rational perspective, there seems to be no basis for the massive popularity of the Fairy Pools.

But Sushil Bikhchandani and colleagues from the University of California published a paper in the top ranked Journal of Political Economy way back in 1992. It has become very well known in economics.

The specific purpose was to account for “herding” behaviour within the framework of rational choice. Or, as the authors put it, to identify when it is optimal for an individual to follow the behaviour of others without regard to his or her own information.

In their model, an individual has both private and public information and assigns weights to the two when making a choice. A new piece of information arrives, and the weights are updated.

When you read on the internet that the Fairy Pools are fantastic, you increase the weight on the public information which you have. It is easy to see how, in such circumstance, certain things can become incredibly popular. They are not necessarily popular on account of their inherent characteristics. They become more popular simply because they are already popular.

It was consoling, as we pondered how to escape the massive traffic jam in remote Glen Brittle, that rational choice theory is indeed able to explain the phenomenon.

Paul Ormerod 

As published in City AM Wednesday 22nd August 2018

Image: Edinburgh Fringe by Wikipedia is licensed under CC BY-SA 3.0